Software as a service, or SaaS, is one of the fastest growing industries in the world. It can include anything from analytics dashboards like Cyfe to marketing automation companies like HubSpot to industry specific software. Because of the nature of a software as a service company, data has to be a driver in every single decision from adding new features or products to marketing spend. Data is the lifeblood of any business, but that is especially true of SaaS companies. The problem here is that SaaS companies have access to, dare we say it, too much information. It’s difficult for some software as a service businesses to understand which SaaS metrics to track closest and how they impact their business.
While many businesses rely on a recurring revenue (or retainer) business model, software as a service businesses almost exclusively rely on it. It’s something that can be a huge benefit, but also a huge problem if a customer isn’t happy with the service shortly after signing up. Due to the increasing costs of acquiring a customer (across all industries) because of continuously increasing competition, SaaS companies are investing more in customer acquisition. This isn’t necessarily a big issue if the company delivers on its promises and keeps their customers happy. Doing so increases the customer lifetime value (CLV) and the longer a customer is with a SaaS company, the more the profit margin increases. The problem comes in when a customer leaves the SaaS company within a short period of time after signing up. When this happens it is possible (even likely) that the company lost money on that customer.
Due to this unique business model, SaaS companies need to monitor several specific SaaS metrics in order to make sure they’re operating profitably, adding new customers, retaining their current customer base, and spending their money wisely.
Let’s dive into four must have SaaS metrics that your software as a service company should be monitoring very, very closely.
Due to the recurring nature of SaaS, you can’t simply look at what you charge a new client to onboard and their monthly fee as their value. You’ve got to consider the lifetime value of each customer to get a much clearer picture of what that customer is worth to your business. Depending on your type of model, MRR or ARR (monthly recurring revenue or annual recurring revenue), you’ll likely calculate the lifetime value of your customers a little differently. With an MRR model, you’re likely charging your customers on a month to month basis (though you may have a contract in place for a year or longer). With an ARR model, you’re charging your customers once per year (likely with just a one year agreement).
No matter the way you have structured your business and fee schedule, your customer lifetime value is one that can’t be overlooked. You need to understand how much the average customer is worth to you over the entire time they work with you. Let’s calculate that number…
LTV = [(Avg. Monthly Transactions X Avg. Order Value) Avg. Gross Margin] x Avg. Lifespan in Months
LTV = [(Avg. Annual Transactions X Avg. Order Value) Avg. Gross Margin] X Avg. Lifespan in Years
This metric is actually one that may change over time as you get (hopefully) better at pleasing your customers and they hang around longer. It can also change if the cost of your services increases or decreases or if your costs change. We recommend monitoring this value closely and recalculating it on a quarterly basis to have as accurate of information as possible throughout the year.
PRO TIP: Set up a Google Spreadsheet that calculates the time each customer has been with you as well as their monthly or annual costs. Doing this, you’ll easily be able to monitor your LTV throughout the year. You can also set that sheet to feed into your business analytics dashboard.
Now let’s talk about adding new customers. Adding a new customer is NEVER free, especially in the SaaS world. With so much competition out there in every SaaS niche and market, monitoring your Customer Acquisition Cost (CAC) is vital to your success. Your CAC is the average cost that you’ll pay to acquire one new customer. This can be in the form of advertising costs, marketing, time spent, and more.
If you’re a SaaS startup, you’re likely underestimating this metric because you’re blinded by how excited you are about your software. You’re likely expecting customers to adopt your software at a higher rate than they actually will and thus underestimating your costs. Especially in the startup phase of your SaaS company, you can’t afford to be overly optimistic, you need to rely on hard data in order to stay in business and become profitable. Let’s take a look at how to compute this number.
CAC = (Sum of all Sales & Marketing Expenses) / (Number of new customers added)
This is another metric that you should be monitoring constantly because it will also likely change fairly frequently as your marketing and sales expenses increase or decrease and as your business is introduced to the market. Especially in the early years, your CAC will likely fluctuate almost daily!
Probably the most important ratio that you need to understand in your SaaS business is your customer lifetime value to your customer acquisition costs. This ratio will give you an honest evaluation of the viability of your business (which is very important in when you’re starting up a new SaaS company). Many businesses, especially in the tech space, rely on investment money early and don’t start producing a profit until around year four, but relying on that investment money without understanding when (and if) you will ever turn a profit is playing with fire. So many businesses in the SaaS space flame out due to not understanding the viability or LTV to CAC ratio of their business.
So, really there are two pieces to this pie. You need to understand your customer lifetime value and how it relates to your customer acquisition costs (hopefully it’s a positive number!) and you also need to understand how long it will take to recover the CAC spent to acquire each customer.
Let’s do an example to illustrate:
Say you figure out that you’re spending on average $300 to acquire a new customer (using the equation above) and your average customer lifetime value is $1,500, you can calculate your LTV to CAC value as 5x.
But is 5x a good or bad ratio? This means that your business is making five times what you’re spending on each customer to acquire them. Obviously, the higher this ratio, the better and more successful your business will be. As a good rule of thumb, a viable SaaS company should have a LTV to CAC ratio of 3x or greater.
Next you want to determine the time it will take to recover the amount spent on acquiring the average customer. In order to do this you’ll need to calculate the average gross margin (which you did to get your customer lifetime value) and map it out until you reach your break even point.
So, say you have an average monthly gross revenue of $100 per new customer, you can see that it will take you three months to recover the investment that you paid in order to acquire that new customer. As another rule of thumb, you should shoot to recover your investment within the first year.
Now, taking this data back to our first point, if you are to lose this customer within the first two months, you are losing money on that customer.
MRR or ARR Churn
Like we talked about earlier, we want to make sure that customers are staying with your SaaS company for as long as possible because the longer that they are with you, the higher your margins will be.
In order to understand your lost business, you’ll need to calculate your monthly recurring revenue or annual recurring revenue churn rate. This is a calculation of what percentage of revenue was not renewed or was cancelled throughout the year (or quarter or month).
MRR Churn can be calculated as follows: (substitute ARR if needed)
MRR Churn = (∆MRR cancelled contracts) / (∆t X MRR total)
Essentially, here if you have $1,000,000 in monthly recurring revenue at the beginning of the quarter and 2 of your customers cancel or don’t renew and they represent $200,000 in MRR, your quarterly MRR churn is 20% (which is extremely high).
As your business grows, becomes more sophisticated, and better understands your customers you should be able to increase the lifetime of your customer as well as decrease your MRR churn rate, at least those should be goals that are very high on your priority list.
Now, that we’ve gone through our top four must have SaaS metrics that you should be monitoring, you need a place to actually monitor those metrics, right? Get started with Cyfe now for FREE! Build out your SaaS metrics dashboard right within Cyfe and feed information from over 200,000 applications to help you seamlessly calculate and monitor these metrics!